August 18, 2003
Financial Services Agency

Announcement of the ''Program Year 2003 Basic Guidelines and Basic Plan for Inspections''

We are announcing the ''Program Year 2003* Basic Guidelines and Basic Plan for Inspections'' in the interest of improving transparency of the administrative work associated with financial inspection.

* ''Program year 2003'' refers to the period from July 1, 2003 through June 30, 2004.

For further information, please contact:

Mr. Ono (ex. 2502)
Mr. Horimoto (ex. 2504)
Mr. Hara (ex. 2517)

Inspection Coordination Division (03-3506-6000)
Inspection Bureau
Financial Services Agency of Japan

(Provisional translation)

''Program Year 2003 Basic Guidelines and Basic Plan for Inspections''

I. Basic Guidelines for Inspections

    Under the basic policy that fair and transparent financial administration should be achieved together with clear rules based on the market discipline and the principle of self-responsibility, the Financial Services Agency (FSA) has made continuous efforts of implementing efficient and effective inspections with ''Financial Inspection Manual'' in order to stimulate financial institutions to build internal control based on the self-responsibility.

    In the program year 2003 (July 1, 2003 to June 30, 2004), the FSA will continue to carry out accurate and effective inspections, based on various measures conducted in the previous program year and considering current environment surrounding financial institutions. It will place particular emphasis on the following basic ideas.

1. Measures conducted during the program year 2002

(1) Implementation of profound inspections on major banking groups
  1. Introduction of year-round inspections by specialized sections corresponding to each major banking group (July, 2002)
        Inspection units responsible for major banks were reorganized so that each of the units corresponded to a major banking group. The new system allowed each unit to watch a certain banking group throughout a year by inspecting in turn financial institutions and holding companies within the assigned group.
  2. Promoting tighter assessment of assets
        Following measures in the ''Program for Financial Revival'' (released in October, 2002) were implemented in order to further tighten assessment of assets by major banks.
    a)     Disclosure of the gap between self-assessments by major banks and the results of the FSA's inspections on an aggregated basis (November, 2002)
    b)     Conducting another round of special inspections focusing on borrowers whose market reputations were significantly changing (commenced in January, 2003; release of the results in April, 2003)
    c)     Intensive examination of the appropriateness and the progress of reconstruction plans by a special team (established in December, 2002) (carried out in unison with the above special inspection)
    d)     Introduction of the Discounted Cash Flow (DCF) type method for provisioning
    The FSA announced a revised version of the ''Inspection Manual'', which introduced the DCF type method, in parallel with the release of a new guideline by the Japanese Institute of Certified Public Accountants (JICPA) on the same subject. The FSA began to check how the major banks applied the new method through inspections targeting the accounting period ending March, 2003.
    e)     Harmonizing borrower classification of large debtors with loans from more than two major banks (started from January, 2003)
  3. Timely inspections targeting on compliance functions regarding capital increase (from April to June, 2003)
(2) Ensuring the implementation of appropriate inspections fully taking into account the actual business conditions of small and medium sized enterprises (SMEs)
  1. Measures to ensure appropriate application of the ''Supplement to the Financial Inspection Manuals: Treatment of Classifications Regarding Credits to Small and Medium Sized Enterprises'' (the ''Supplement'') (released in June, 2002)
    a)     Having inspectors fully understand the contents of the ''Supplement'' through training programs such as a trial run of assessment of assets
    b)     Holding seminars to deliver explanation of the ''Supplement'' to financial institutions and borrower companies (382 seminars held for various parties including the Chamber of Commerce and Industry all over the country by the end of June, 2003)
    c)     Based on the ''Action Program for Strengthening Relationship Banking Function'' (announced in March, 2003), the FSA initiated a review of the ''Supplement'' to further reflect the actual business conditions of small and medium-sized companies. As part of the review process, the FSA carried out a survey to assess how well the ''Supplement'' was recognized by different parties.
  2. Utilization of information obtained through the ''Hotline for Credit Crunch and Credit Withdrawal'' (set up in October, 2002), in the course of inspections
  3. Rigorous implementation of on-site monitoring system for inspections, where supervisors of inspectors visit financial institutions during the inspection period to listen directly to opinions of the management
    (note) On-site monitoring for inspections was implemented to 341 financial institutions, which accounted for approximately 80% of the total inspected in the program year 2002.
  4. Improvement of the ''opinion submission system'', where inspected financial institutions can submit their opinions in case they differ from inspectors' views (January, 2003)
    (note) The revisions were made to such issues as the deadline and the place for submission.
(3) Appropriate responses to current challenges
  1. Conducting inspections by special teams each consisting of experts familiar with specific areas such as market risk or risk related to computer systems (The teams were established in July, 2002)
        With the ability to act separately from the year-round inspection units, they examined specified areas across the different major banking groups or carried out inspections for those financial institutions planning to unify their computer systems.
  2. Establishing and announcing the ''Check List for Risk Management of System Integration'' (December, 2002)
  3. Establishing and announcing the ''Inspection Manual for Financial Holding Companies'' (July, 2003)

2. Priorities in the Program Year 2003

    The FSA will carry out inspections in the Program Year 2003 (July 1, 2003 to June 30, 2004) with a view to appropriately responding to the various changes surrounding financial institutions. It places particular emphasis on the following items including measures introduced in the previous program year.

(1) Implementation of more profound inspection to each major banking group
    In order to bring about tighter asset assessment by major banks, the FSA will continue to carry out the measures implemented following the ''Program for Financial Revival'' in the context of the year-round inspections. They include (a)announcing the gap between major banks' self-assessment and the result of FSA's inspections, (b)implementing examinations of debtor companies' reconstruction plans by the special team, (c)harmonizing borrower classification of large debtors among major banks, and (d)closely checking the state of deferred tax assets. At the same time, the FSA will take necessary measures responding to the changes in the financial environment. It will also check compliance and risk management function of each financial group as a whole, based on the recently issued ''Inspection Manual for Financial Holding Companies''.
(2) Ensuring the implementation of inspections properly appreciating the actual business conditions of SMEs
    The role of financial institutions in credit business is to provide money to enterprises smoothly while taking risks with proper risk management. The financial institutions, when they act as intermediaries, look at different aspects depending on whether the borrower is an SME or a major enterprise. Bearing such features in mind, and building on the achievements made in the previous program year, the FSA will put particular emphasis on the following measures in order to carry out appropriate inspections appreciating the actual business conditions of SMEs.
  1. Revision of the ''Supplement''
        The FSA will continue to take actions to make the ''Supplement'' better-known to those concerned. Simultaneously, the FSA will grasp, through analysis of the survey, the issues left to be solved and the extent to which the ''Supplement'' has been disseminated, and revise the ''Supplement'' to reflect the actual business conditions of SMEs more accurately.
  2. Examination regarding financial institutions' accountability to their borrower companies
        The Guideline for Supervision was revised on July 29, 2003, with regard to the part on deposit-taking institutions' accountability to customers and internal functions to deal with complaints and claims. The FSA will inspect how well the accountability is being met in accordance with the revised Guideline. The priority of inspection will be put on finding out whether each deposit-taking institution properly explains its decision to alter terms of loan transactions in accordance with its business strategy or vision. The FSA will also check whether the financial institution improperly uses the FSA's inspection or Inspection Manuals as an excuse in changing terms of loan transactions.
(3) Measures to ensure protection of users and improve users' convenience
    It is a general principle that financial institutions receive adequate remuneration only when they provide various financial services matching the needs of users, while making efforts to improve protection and convenience of users. Therefore, it is required that financial institutions properly fulfill their responsibilities and obligations to customers including accountability and duty of faithful trustees.
    Reflecting such a view, the FSA will carry out inspections with emphasis on the following points, for the purpose of ensuring protection for users and increasing users' convenience.
  1. Checking execution of accountability
    a)     Accountability to depositors, policyholders and investors
        Concerning features and risks of the financial products, the FSA will review what contents are informed, how they are informed, how customers' consent is confirmed, and how appropriately the system to supervise these issues is set up.
    b)     Accountability to borrowers
        Concerning the schemes and risks of the loan transactions, the FSA will examine what contents are informed, how they are informed and how customers' consent is confirmed at the time of contract, as well as how appropriately the system for checking these points is set up, based on the revised Guideline for Supervision and other related regulations.
  2. Examination of the state of compliance including with duty of faithful trustees
        The FSA will examine the state of financial institutions' compliance including with duty of faithful trustees or duty of providing documents to customers. It will also check whether the system is appropriately structured to ensure that the financial institutions act in accordance with such duties.
  3. Examination of systems related to managing customer information
        In order to protect customer information, the FSA will check whether the financial institutions obtain customer agreement on documents when sharing customer information within the financial group, whether systems to manage such information are in order to prevent leaks, how adequately security measures are implemented to prevent unauthorized access to customer information, and so forth.
  4. Examination of systems to deal with complaints, etc
        In addition to examining whether financial institutions establish system to deal with complaints from customers, the FSA will check how effectively they deal with complaints from customers, and how adequately complaints important for the institution's operation are reported to the senior management. As for deposit-taking financial institutions' response to claims from borrowers, the FSA will inspect how appropriately the system for customer service is set up, based on the revised Guideline for Supervisors.
(4) Examination of management function of the risk associated with computer systems
    Computer systems are indispensable and fundamental infrastructure for financial institutions' business, and the importance of preventing troubles with the systems has been increasing in recent years. Furthermore, the risk related to system integration has been expanding through reorganization of financial institutions accompanied by integration of computer systems. Responding to those situations, the FSA will continue to examine management function of computer system risk, using the ''Checklist for Management Function of System Integration Risk''.
(5) Implementation of inspections of government financial agencies and postal agency
    The FSA will inspect the accuracy of self-assessment of assets, the appropriateness of write-offs and provisioning, and the appropriateness of the internal control function, bearing in mind each institution's character. The inspections will be based on the ''Inspection Manual for Deposit-Taking Institutions'', the ''Inspection Manual for Insurance Companies'' and other manuals, which are used in inspections to financial institutions in the private sector.
(6) Activities to profound inspections corresponding to characteristics of each financial area.
    In addition to the above measures from 2.(1) to 2.(4), the FSA will conduct profound inspections, in accordance with characteristics of each financial area.
  1. Financial holding companies
        The FSA will conduct inspections in response to the integration of management within each financial institution group using the recently issued ''Inspection Manual for Financial Holding Company'', bearing in mind the current trend where financial institutions are forming conglomerates and barriers between different financial sectors are being lowered.
  2. Deposit-taking financial institutions
        As for deposit-taking financial institutions, the FSA will implement inspections with particular emphasis on the governance of the management including internal audit function, in addition to whether the risk management system accurately reflects changes in economic and financial environment and risks to ensure financial soundness. It will also check whether each financial institution implements Know-Your- Customers (KYC) policy adequately, abiding by the law for identifying customers, implemented in January 2003.
  3. Trust banks
        The FSA will carry out inspections on trust banks taking into account fundamental features of the trust business, which is to manage and dispose of others' property. It will mainly focus on accountability to customers, while making efforts to grasp the actual business conditions.
  4. Insurance companies
        As regards insurance companies, the FSA will examine the management of insurance policy sales and the corporate governance. It will also check risk management system with high priority, while properly grasping the actual business conditions both of life and non-life insurance companies, paying due attentions to risks inherent in their business.
  5. Securities firms
        The FSA will implement inspections of securities firms, paying special attention to the state of separate management of client and corporate assets, the accuracy of capital adequacy ratios, compliance, and accountability to customers.
  6. Investment trust management companies, and investment advisory services
        With regard to investment trust management companies and investment advisory services, inspection will focus on accountability to clients, appropriateness of system for managing asset, compliance to fiduciary duties, and duty of providing documents to clients.
  7. Foreign financial institutions
        The FSA will carry out inspections regarding foreign financial institutions (banks and securities firms, etc.) following the policies from A. to F. stated above. In addition, the FSA will place particular emphasis on their compliance to applicable rules and regulations as well as their risk management function, while grasping as a whole the actual state of each financial group which covers several financial areas.
  8. Other financial institutions
        As regards non-banking money lenders, the FSA will conduct inspections focusing mainly on compliance to regulations governing lending rate caps and loan collection behaviors, based on the recently revised law which regulates non-banking money lenders.
        As for the issuers of prepaid cards, the FSA will inspect the situations of reserving adequate guarantee money.

II. Basic Plan for Inspections

Basic Plan for Inspections

Note: (1) These inspection numbers may be changed as necessary.
(2) Under the year-round inspections and inspections by specialized sections, the FSA has been implementing inspections more than once to a number of major banks and holding companies of major banking groups; i.e., as ordinary inspections, as special inspections, and so on. Nonetheless, those inspections to one company are counted as one inspection.
(3) Figures on the ''Banks'' are the aggregated amounts of inspected banks and inspected bank holding companies. Those of ''Insurance companies'' are also the aggregated amounts of inspected insurance companies and inspected insurance holding companies.

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